EC2013 SEMESTER 2

TUTORIAL 2

THE SUPPLY SIDE


Please prepare your answers in advance of the tutorial.


1. Explain in words and using a diagram what is meant by labour market clearing. Why is labour market clearing not observed in real—world labour markets?


2. Why is the wage-setting curve upward sloping? If there is a disutility of working, why are workers unhappy when they are unemployed?


3. Derive the price-setting curve. What does the equation for the PS curve tell us about the ability of firms to make supernormal profits? Explain in words why the decisions of firms about what price to set has implications for the real wage in the economy. Provide two different explanations for why the PS curve might be flat.


4. Explain in words the inflationary consequences of an upswing in aggregate demand. Assume the economy is initially at equilibrium and make sure you adequately explain the transmission mechanisms as well as the final result.


5. Evaluate the following statement:

"When the economy is in equilibrium in the WS−PS model, there is only voluntary unemployment, because no agent has an incentive to change their behaviour".


6. Use the W S − P S model to graphically derive a set of Phillips curves. Explain the intuition behind the diagram. Provide an explanation as to how a situation of deflation could occur (deflation is a situation in which inflation is negative so that prices are falling). What are you assuming about the real interest rate?


7. Giving in each case an example of what could have caused it, explain how unemployment can be above equilibrium due to the following. Use diagrams, such as those in Fig. 2.15, to show the inflationary implications of each shock (assume there is no stabilizing policy maker).


8. Read the following statement and then answer the questions below: “Just by looking at real-world labour markets, it is obvious they are far too complex to be accurately modelled by either the efficiency wage model or the textbook model with complete contracts”. [Hint: the textbook model is set out in the appendix.]

(a) Does the statement provide a good justification for not using a model when thinking about the supply side of the economy?

(b) What are the key predictions of the efficiency wage model and the textbook model with complete contracts?

(c) The predictions of which model more closely match what we observe by analysing real-world data? Provide examples to justify your answer.


9. Consider two key events in recent economic history; the credit crunch that plunged the world into recession in 2008 and the Fukushima nuclear disaster that struck Japan in 2011. Find data on the path of the monthly harmonised unemployment rate from the start of 2007 onwards for both the US and Japan using OECD.Stat. Answer the following questions:

(a) Describe (i) how US unemployment reacted to the credit crunch; and (ii) how Japanese unemployment reacted to the Fukushima nuclear disaster.

(b) Using the material in this chapter and the previous chapter, make an assessment of which curves were likely to have been affected by these economic shocks – i.e. was it the I S, W S or P S curve that were affected (or some combination of them)? Make sure you justify your answer.

(c) Given your answer to part (b), do you predict that the equilibrium level of unemployment shifted in response to these shocks? Justify your answers.